Rebalancing Act for Your Portfolio

Has the latest pullback in precious metals and related stocks given you a sickening feeling in the pit of your stomach?

If so, then consider rebalancing – because that sinking feeling is a
good signal that you are probably overinvested in the sector. I’ll have
more on that topic in a moment, but first to the question of where to
invest, if not in precious metals and resource stocks? That is a
question we get quite often.

For the time being, as least for those without international
obligations, the carrying cost of cash is very low. Thus you can reduce
your near-term risks, albeit at the cost of forgoing upside. If at one
end of your portfolio “barbell” you have a 20% to 33% allocation to
precious metals, having the same sort of allocation to cash on the
other end of the barbell brings overall risk down while giving you the
liquidity to act as additional opportunities arise.

As for the “middle,” consider building a portfolio diversified between
undervalued food and energy stocks (constant needs) and high-potential
tech stocks.

I include the latter because tech is one of the few remaining sectors
where U.S. companies still have an edge. Secondly, the infusion of
money from QE2, QE3, and so on will almost certainly have a positive
effect on the broader U.S. stock market. While not a direct correlation
to the situation today, as you can see in the chart just below,
Japan’s predecessor experiment in quantitative easing clearly produced a
dead-cat bounce in that country’s stock market. As you can also see,
almost immediately after pulling the plug on the QE, the stock market
fell back to depressed, pre-QE levels.

The importance of this information is two-fold:

It suggests that as long as the government keeps a heavy
foot on the money-printing pedals, the U.S. stock market should,
if nothing else, maintain. While we will almost certainly see a
lot of volatility and perhaps sector-specific crashes – for
instance financials, once the scale of the toxic loans becomes
more visible – the broader market should be able to avoid a crash.
Of course, once the plug is ultimately pulled on the Fed’s
monetary madness, as it inevitably will be, then watch out below.
But based on Bernanke’s latest comments, that appears anything but
imminent.
With the risks of a broad market meltdown greatly
diminished, investors – large and small – will be less afraid of
piling into specific sectors that they feel have significant
upside. That will feed into a bubble in the mining shares and
drive up other sectors, including tech stocks. The world loves the
latest and greatest, and the stories of the big tech winners are just
so damn juicy that they regularly make news in all the right ways.

I recommend this because we continue to receive a large volume
of emails from readers sitting on big profits in the precious metals and
related stocks. They love what the stocks have done to their
portfolios, but the size of their gains leave them nervous about a big
correction, or worse. Offsetting those concerns is the clear upside in
the sector (at least clear to us) – gains yet to come as currency
regime change unfolds and the fiat currencies are eventually replaced
with something far more tangible.

The precious metals stocks are going to have a particularly wild ride
in the months and years ahead. While the overarching trend will be akin
to a moon shot, there will be any number of heart-stopping corrections
along the way. And looking at the current price action, we may be on
the verge of one now.

Depending on your personal investment style, there are a couple of
simple approaches you might want to take to that end of the barbell you
have dedicated to the precious metals.

Trade the markets. Buy on our
recommendations, but sell on big surges – for instance, of the
sort we have seen of late. Wait for the next correction to reload
and do it all over again. Of course, this gives rise to the
possibility of missing a really, really big move. Which brings up…Know what you own, and hang in there…
at least until a hard exit target is met. I personally have owned
several holdings for years. Not because I view them as heirlooms,
but because they keep surmounting each successive hurdle on the
way to production or, more likely, a buyout. During corrections,
as often as not, I just buy more.Use trailing stops. Because these stocks
are very volatile, though, you are probably going to want to be
fairly generous in where you set your stops… 15%, 20%? Otherwise,
you could get knocked out at the wrong time, for the wrong reason,
and miss the quick bounce. Also, it’s important to remember that
the juniors are especially thinly traded. That’s important,
because if your trailing stop is hit, your shares will be sold “at
the market”… in other words, for whatever someone is willing to
actually pay for them. Thus, on a really bad day, your stop limit could
be triggered… but your stocks find no bid and plummet, eventually
changing hands far below your limit.

(If you work with a good broker, rather than putting your order into
the system to be blindly sold at the market if your stop is hit,
they’ll agree to keep it “on the desk.” Which means that if your
trailing stop is hit, they’ll actively begin trying to work your
stock into the market for the best possible price, as opposed to
blindly dumping the entire position at the bid, wherever that
might be.)Sell puts. If there is a stock you like
and would like to own more of, consider selling puts – which
contractually obliges you to buy a certain stock at a certain
price, if it hits that price. In exchange, you receive a
commission. As long as the stock is moving up, sideways, or even a
bit down, you are off the hook, having earned a nice commission
for your guarantee. On the other hand, if the stock falls to the
point that it gets put to you, then you’ll be forced to buy it,
but at a cheaper price than the current market – with your net
cost lowered further by the commission you received. Again, however, in a
freefall, you could be forced to buy more of a stock at a price
that is well over the then-current market.

Those are just the broad strokes, and there are of course additional
strategies you can use to mitigate risk while continuing to seek the
explosive upside of the sector. But, again, I have to say that no matter
what strategies you deploy, the only way to keep a cool head in the
face of potentially extreme volatility will be to invest only with
money you can afford to lose at least half of. Overinvesting in the
sector will make you far more prone to panic and bad decision making.

And if you have enough of an allocation to the precious metals and
enough cash, then you can look for other sectors with big upside and
with a downside risk that can (mostly) be managed with thorough due
diligence and in-depth industry knowledge.